Class 6: ESG Flashcards
why is there a growth in ESG incorporation?
Institutional investors were recently surveyed to find out what is the most significant reason for ESG incorporation
The number one reason was risk reduction
A close second was client demand
why are public pensions adoption of ESG accelerating?
These investors control a large share of the world’s invested capital
Some are focusing on engagement and shareholder activism, while others adopt a divestment approach
Fossil fuel investments are targeted the most but other negative investment screens have been considered.
There seems to be a worldwide consensus adoption of the goal of “net-zero carbon by 2050” to deal with climate change.
This goal is found convenient because for many actors, there is still time to postpone economically difficult or politically risky decisions.
For investors, net-zero carbon could mean full divestment from carbon emitters, but instead could mean some retention of carbon emissions exposure combined with investments that balance it out (or seem to).
What are some common elements of ESG?
Link a firm’s impact on ESG factors to stakeholders
Stakeholders actions impact a firm’s profits and loss statement
Revenue growth
Gross margins
Productive efficiency
Flow through a firm’s stakeholders
Enhance its ability to create and
appropriate value
Disrupt those processes
What is the E of ESG?
Influence climate change through their emissions of greenhouse gases (GhG)
Carbon
Methane
Nitrous oxide
Ozone
Chlorofluorocarbons
They also set off a series of reactions from the natural environment
Other stakeholders then can impact their bottom line
what are the social factor - employees?
The amount they are paid
The conditions they work under and the composition of the workforce
The broader effects of the composition
Workers whose wages leave them unable to feed their family are more likely to
Quit
Work additional jobs
Less motivated when they do work
Can be less productive
Inequality in pay across and within jobs classes can also breed resentment and demotivate less well-paid workers to an extent that offsets the incentive benefits achieved by their higher paid counterparts
what are the social factors - physical conditions?
Rate of accidents and negative health effects of employment
Extending to the use of child labor or other coerced labor
Regulatory inquiries and lawsuits can add additional costs to the health bills and costs involved in attracting and retaining workers
In emerging markets
Regulations are less binding
Easily evaded with a bribe
Otherwise not enforced
Trade agreements and social activism are increasing the transparency to such violations and the cost of having firms engaged in these practices within your supply chain
what are the social factors - composition of the workforce?
Gender, racial, ethnic, religious or other easily observable criteria can create tangible benefits and costs
Diversity, equity, inclusion and a shared sense of purpose can make members of these groups feel more connected to and engaged with their employer, stimulating productivity
Send signals to customers from the same group or suppliers who have characteristics with similar benefits
Customer willingness to pay
Supplier demands on price
Other studies report higher creativity and greater resilience
governance in ESG?
what are some characteristics that determine the board of a company?
what are some challenges of measuring social impacts?
Measuring social impacts is fraught with problems
A first-order problem is quantifying the amount of social impact needed to offset a lower risk-adjusted return
Even assuming the social impact can be precisely measured, the trade-off may or may not be desirable, depending on the investment goals and the social values of the decisionmaker
what are some more challenges of measuring social impacts?
Another first-order problem is what we can call “apples vs. oranges,” or the “comparison problem”
There is no one set of agreed-upon definitions, standards, methodologies, or units of measurement; and variance of values and missions means standardization may never be possible
A potential pathway to standardization is the largest actors in the measurement community using scale and market power to enforce their own approach
MSCI appears to be attempting this
However, barriers to entry are quite low in
the impact measurement business, and a
uniform approach appears to be a distant
goal
what are some causes of bias and distortion in impact measurements?
Survivor bias: Set of reporting entities is skewed because failures don’t report
This is a well-known problem in hedge fund indexing
Subjectivity: Many impact measurement metrics are simplistic ratings, for example a 1 to 5 scale
Often there is a subjective element in the rating
A subjective determination is not the same as a measurement
Conflicts of interest
A conflict can arise when the rater earns fees, creating a “grade inflation” incentive so fees will continue and increase
After the 2008-2009 financial crisis began, bond rating agencies were accused of such conflicts, especially in rating credit derivatives
The Impact Investing community is still relatively small and collegial— may be reluctance to assign poor ratings to a popular or influential entity
Outputs are not necessarily the same as outcomes
A widely discussed measurement problem in U.S. medical care
Choice of units across diverse measures
With ratings: Intra-rating consistency, inter-rater consistency
Consistency of definitions over time
Orthogonality of ratings (and also measurements); transparency is correlated with G and S and E
what are the MSCI indices?
MSCI Global Sustainability Indexes
Target highest ESG-rated companies making up 50% of
market cap in each sector of underlying index
MSCI World ESG Index
Large & mid-cap securities in developed countries, parent index MSCI World
Include companies with high ESG rankings relative to sector peers
Target sector distributions reflecting those of parent indices
what is the MSCI VIA (Intangible value assessment)?
